The long-awaited AB-5 bill has arrived after a 2018 state court ruling changed the way California differentiates between employees and independent contractors (ICs). The court set the three-part ABC test as California’s method of determining a worker’s status, shifting it away from the more ambiguous, employer-friendly federal standards. The AB-5 bill then further codifies the rights and benefits owed by the employer after a former IC has been reclassified as a full employee. AB-5 recently passed the state assembly and heads to the state senate in just a few months.
Why is this law causing such a stir? So-called gig economy companies who deliver most of their services via independent contractors — such as rideshare and delivery apps — may be required to transition thousands of their workers to full employee status, thereby entitling them to better benefits like collective bargaining power, parental leave, overtime pay, minimum wage, and health benefits. But while the Ubers of the world are the companies everyone seems most focused on, it could end up affecting many more traditional industries as well.
While the debate has been brewing for years, the turning point came in a court ruling on the Dynamex Case last year, which implemented the three-part ABC test. Employees must meet all three criteria to be considered an IC:
“(A) …the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact;
(B) …the worker performs work that is outside the usual course of the hiring entity’s business; and
(C) …the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.”
Below, we’re going to explain what each of those criteria means and tell you more about what the ABC test would mean for your business. But first, let’s look at how we got here in the first place. Though ridesharing companies Uber and Lyft have found themselves in the spotlight of this ongoing battle, the story goes back over a decade.
How did we get here?
As of May 2017, the Bureau of Labor Statistics reported that 6.9 percent of the U.S. workforce was classified as an independent contractor — nearly 10.6 million people. But it’s unclear how many of them should in fact be counted as regular employees. The Economic Policy Institute, for instance, reported in 2015 that between 10% and 20% of employees are miscategorized under federal standards.
Why the confusion?
Both the hiring company and the employee can benefit from IC status. The arrangement offers flexibility for both sides and, when applied correctly, gives ICs the control they need to grow and develop their own independent business.
However, federal standards for determining who’s an employee and who’s an IC are notoriously ambiguous, which opens up the possibility for unscrupulous companies to save money by misclassifying their employees. Contractors have little recourse when this happens, since ICs have virtually no power to bargain collectively.
Uber’s ongoing role
Many point to Uber as the prime example of a company abusing the IC designation to save money. For instance, in early 2016, Uber slashed ride prices, in what many saw as an attempt to boost low-season rides and impress investors ahead of a planned IPO. Naturally, drivers were unhappy — lower ride prices mean less money for them. But while several drivers complained, their IC status meant they had limited ability to work against the pricing changes.
This came in the midst of a nearly six-year class action suit brought against Uber by its employees in California and Massachusetts. Though Uber reached a $20 million settlement in the case, that outcome didn’t solve the long-term question of how its workers ought to be classified.
The Dynamex case
The Uber situation gives context, but the turning point for the ABC test was a court ruling in 2018 on a case dating back to 2005. Delivery drivers from a company called Dynamex Delivery West fought against a 2004 move by the company to transition all employees to IC status, presumably to save money.
Despite the change, employees were still required to represent the company in specific uniforms and cover driving costs themselves — all while no longer receiving the same benefits and protections they did as employees. California courts deliberated for over a decade, eventually siding with the Dynamex drivers and settling on the ABC test as its standard for differentiating ICs from regular employees.
Breaking down the ABC test for independent contractors
The ABC test comes from an amalgamation of state and federal laws already in existence. Twenty states use some of these guidelines in one form or another for differentiating between employees and ICs.
Federal law follows a very similar structure in that the employee-employer relationship must meet a list of standards proving the contractor is an independent business and not an employee of the hiring company. However, the federal list of standards is quite long and in some cases subjective, which can create confusion around employees’ true status.
The ABC test simplifies the question of contractor vs. employee by reducing the list to a simple three-part test — an employee must meet each of the three criteria to be classified as an IC. Let’s look at each one.
…the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact;”
When an employee is free from “control and direction of the hirer,” this pertains to three forms of control: financial, behavioral, and the nature of relationship between the two parties. The IC must have a say over how they are paid, schedule of payment, salary level, and reimbursed expenses. Behaviorally, the company cannot directly control how the IC performs their job. The relationship component refers to the length and permanence of the contract.
Let’s look at a good example: A financial firm wants to change the look and layout their NYC office. They bring in a certified interior designer to conceptualize the redesign. The interior designer runs her own independent business and therefore sets her own rates, plans to finish work with the company once the design is complete, and ultimately decides how to conduct her work.
“…the worker performs work that is outside the usual course of the hiring entity’s business;”
This new addition to the IC test may be the most significant. It’s a significant expansion of federal standards and now plays a lead role in determining employment status. If the hiring company employs someone to fulfill the primary function of its business — such as Uber and Lyft hiring drivers from their rideshare company — the employee is not an IC under the ABC test.
Back to our example: The financial firm outsources its office redesign to an interior design expert. Design is not related to the primary function of the firm and therefore the relationship with the designer passes test B.
“…the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.”
Requirement C further stipulates that the IC must function as an independent business. The employee is a professional in their field, often holding extensive training, certifications, or a rich background in the specialty. Certification or establishment in their field is not necessary to meet this requirement, though it is a clear sign sign the worker intends to manage their own self-employment. Most importantly, the contractor manages their career by providing expert services to a range of clients. They control the direction of their work — how the work is completed, with whom they work and their pay rate — as one would when running an independent business.
In our example: The interior designer in this scenario markets her services to a range of clients and maintains several simultaneous projects. Though they work for the financial firm at the moment, this job is one project in a series of many during the year.
What would the ABC test mean for your business?
If your business is in California or you employ people there, there’s a good chance you could soon be held to the ABC test. But even if it’s not, it’s worth considering what adherence to the ABC test would mean — other states may soon adopt similar policies as the public pushes for more worker-friendly policies.
Shifting employees from ICs to full employees would come with additional costs, though doing so will ultimately help you avoid fines for misclassifying workers. When making the change, it is important to budget for the following expenses:
- Unemployment and Social Security taxes
- Unemployment insurance
- Health benefits
- Employee record keeping
- Administrative costs
Affected companies should watch for coming changes in the next several months, especially as the AB-5 bill heads to the state senate at the end of the summer. As the gig economy grows, labor laws will change to ensure all workers are protected adequately.
Keep an eye on the laws
Labor laws can always change, but rarely without warning. If you pay attention to new laws that crop up in other states and think about what they would mean for your business, you won’t get caught off guard should those laws eventually be passed in your state. So if you rely heavily on independent contractors, keep an eye on how the ABC test is implemented in California. And if you yourself are a business owner in California now, it’s definitely time to start thinking about how your independent contractors will be classified under the new rules.